Liquidation Bounty

A liquidation bounty is a financial incentive paid to participants in a decentralized lending protocol who execute the liquidation of an under-collateralized position. When a borrower's collateral value falls below a specific threshold relative to their debt, the protocol becomes at risk of insolvency.

To mitigate this, the protocol allows third-party actors, known as liquidators, to repay the debt on behalf of the borrower. In exchange for this service, the liquidator receives a portion of the borrower's collateral, plus an additional percentage known as the bounty.

This mechanism ensures that the protocol maintains a healthy collateralization ratio without requiring centralized intervention. It is a critical component of market microstructure that promotes solvency and price stability.

The bounty compensates liquidators for the gas costs, capital commitment, and technical risks involved in monitoring and executing these transactions. It effectively turns the task of risk management into a competitive market activity.